Bonds Reach New Highs; Analysts Know Why

Bond yields over the past couple of days hit a five-and-a-half-month high. Paul McCulley of PIMCO attributes the jump to the market’s unwinding expectations of a Fed easing.“It was dressed up for an easing party, and the band is not going to show,” he said. McCulley and two other analysts were on “Power Lunch” to give their take on which direction rates might go throughout the coming year.

John Ryding agrees. He’s the chief U.S. economist at Bear Stearns. He says the bond market had priced in two rate cuts from the Fed in the first half of the year into yield prices, but now those easings are being taken out.

“We’re taking out the earnings because we’ve had seven weeks of stronger-than-expected data – just about every economic report,” Ryding says. “I think next week’s data on GDP and jobs will be relatively strong and we could take the rest of the rate cuts out and maybe at some point start thinking about the potential for rate hikes in 2007.”

At least one analyst is seeing a different outcome, though. Richard Gillhooly, senior bond strategist at BNP Paribas, still expects to see an easing later in the year. He admits his company has pushed its prediction for rate cuts back a bit, but he says they’re still coming.

Gillhooly says a key dynamic in the past couple of days is the rise in long-end yields, which inevitably push mortgage rates higher. So the support for the strong housing market – lower mortgage rates – won’t be around in the second half of the year. Then the Fed will be forced to announce an easing.

No matter which direction rates go, the analysts seemed to agree that wage pressures and job numbers will be the most important factors for the Fed going forward. Gillhooly says the increase in pay has dominated for most of the past three or four months and with a new Democratic Congress real wage gains will still be in focus. As a result, bond prices will continue to climb.